What is IPO?

What is IPO?

Initial Public Offering (IPO) refers to the process where private companies sell their shares to the public to raise equity capital from the public investors. The process of IPO transforms a privately-held company into a public company.

 This process also creates an opportunity for smart investors to earn a handsome return on their investments.

Investing in IPOs can be a smart move if you are an informed investor. But not every new IPO is a great opportunity. Benefits and risks go hand-in-hand. Before you join the bandwagon, it is important to understand the basics.

Types of IPO

There are two common types of IPO. They are-

1) Fixed Price Offering

Fixed Price IPO can be referred to as the issue price that some companies set for the initial sale of their shares. The investors come to know about the price of the stocks that the company decides to make public. 

The demand for the stocks in the market can be known once the issue is closed. If the investors partake in this IPO, they must ensure that they pay the full price of the shares when making the application.  

2) Book Building Offering

In the case of book building,  the company initiating an IPO offers a 20% price band on the stocks to the investors. Interested investors bid on the shares before the final price is decided. Here, the investors need to specify the number of shares they intend to buy and the amount they are willing to pay per share. 

The lowest share price is referred to as floor price and the highest stock price is known as cap price. The ultimate decision regarding the price of the shares is determined by investors’ bids.

IPO Advantages and Disadvantages

Investing in IPOs comes with both merits and demerits. Here are a few of the benefits and drawbacks you must know before making your investment decision.

Benefits of Investing in an IPO

Investing in an initial public offering withholds the below-mentioned advantages-

Increased Recognition

When weighing the advantages and cons of an IPO, this good factor comes out on top. It assists management in gaining more reputation and credibility by becoming a trustworthy organization.

Companies that are publicly traded are typically more well-known than their private competitors. In addition, a successful process attracts media attention in the financial sector.

Access to Capital

A corporation may never receive more capital than it raises by going public. A company's growth trajectory might be substantially altered by the substantial cash available. An ambitious company may enter a new period of financial stability following its IPO.

This decision can help R&D, hire new employees, establish facilities, pay off debt, finance capital expenditures, and purchase new technologies, among other things.

Diversification Opportunity

When a corporation becomes public, its shares are traded on an exchange amongst investors. This increases investor diversity because no single investor owns a majority of the company's outstanding stock. As a result, purchasing stock in a publicly listed company can help diversify investment portfolios.

Management Discipline

Going public encourages managers to prioritize profitability over other objectives, such as growth or expansion. It also makes contact with shareholders easier because they can't hide their issues.

Third-Party Perspective

When a company goes public, it gains an independent perspective on its business model, marketing strategy, and other factors that could hinder it from becoming profitable.

Disadvantages of Investing in IPO

There are a few factors an investor would have to consider before starting to invest in an IPO-

More Costs

IPOs can be quite costly. Aside from the continuous costs of regulatory compliance for public firms, the IPO transaction process necessitates the investment of capital in an underwriter, an investment bank, and an advertiser to ensure that everything runs well.

Lesser Autonomy

Public companies are led by a board of directors, which reports directly to shareholders rather than the CEO or president. Even if the board delegated authority to a management team to oversee day-to-day business operations, the board retains the final say and the authority to fire CEOs, including those who founded the company.

Some businesses circumvent this by going public in a way that grants its founder veto power.

Extra Pressure

In the midst of market turmoil, publicly traded firms are under enormous pressure to keep their stock values high. Executives may be unable to make hazardous decisions if the stock price suffers as a result. This occasionally foregoes long-term planning in favor of immediate gratification.

Terms Associated with IPO

Issuer

An issuer can be the company or the firm that wants to issue shares in the secondary market to finance its operations.

Underwriter

An underwriter can be a banker, financial institution, merchant banker, or a broker. It assists the company to underwrite their stocks.

The underwriters also commit that they will subscribe to the balance shares if the stocks offered at IPO are not picked by the investors.

Fixed Price IPO

Fixed Price IPO can be referred to as the issue price that some companies set for the initial sale of their shares. 

Price Band

A price band can be defined as a value-setting method where a seller offers an upper and lower cost limit, the range within which the interested buyers can place their bids.

The range of the price band guides the buyers. 

Draft Red Herring Prospectus (DRHP)

The DRHP is the document that makes the public know about the company’s IPO listings after the approval made by SEBI.

Under Subscription

Under Subscription takes place when the number of securities applied for is less than the number of shares made available to the public.

Oversubscription

Oversubscription is when the number of shares offered to the public is less than the number of shares applied for.   

Green Shoe Option

It refers to an over-allotment option. It is an underwriting agreement that permits the underwriter to sell more shares than initially planned by the company. It happens when the demand for a share is seen higher than expected.

Book Building

Book building is the process by which an underwriter or a merchant banker tries to determine the price at which the IPO will be offered.

A book is made by the underwriter, where he submits the bids made by the institutional investors and fund managers for the number of shares and the price they are willing to pay. 

Flipping

Flipping is the practice of reselling an IPO stock in the first few days to earn a quick profit.

Any individual who is an adult and is capable of entering into a legal contract can serve the eligibility norms to apply in the IPO of a company.  However, there are some other inevitable norms an investor needs to meet.

The eligibility criteria are-

It is required that the investor interested in buying a share in an IPO has a PAN card issued by the Income Tax department of the country.

One also needs to have a valid demat account. 

It is not required to have a trading account, a Demat account serves the purpose. However, in case an investor sells the stocks on listings, he will need a trading account. 

It is often advised to open a trading account along with the Demat account when an investor is looking forward to investing in an IPO

CAGR

What is CAGR?

CAGR (Compound Annual Growth Rate) measures your investments' average annual growth over a given period. It shows you the average rate of return on your investments over a year. CAGR is a helpful tool for investors because it precisely measures investment growth (or decline) over time. When calculating CAGR, profits are assumed to be reinvested at the end of each year of the time horizon. Therefore, CAGR is a representative number, not an accurate return. In most cases, an investment cannot grow at the same rate year after year. Despite this, the CAGR calculator is widely used to compare alternative investments.

Keeping this common application of the calculation in mind, it is prudent that investors find a convenient way to calculate CAGR. Anyone who wants to estimate the return on investment can use the CAGR calculator. The Compound Annual Growth Rate formula is used in this application's calculations (CAGR formula). For example, if you have a mutual fund that has appreciated over time, you can use the calculator to determine the rate of return on your investment. The CAGR return calculator will provide you with an annual growth rate that you can compare to a benchmark return.

How to calculate CAGR?

To calculate the compounded annual growth rate on investment, use the CAGR calculation formula and perform the following steps: 

• Divide the investment value at the end of the period by the initial value.
• Increase the result to the power of one divided by the tenure of the investment in years.
• Subtract one from the total.

Mathematically speaking, the CAGR formula is given by the following equation-

CAGR = (FV / PV) ^ (1 / n) – 1

In the above formula, FV stands for the future value of the investment, PV stands for the present value of the investment, and n stands for the number of years of investment. To understand the calculation better, let's look at a hypothetical situation. Consider you invested Rs.20000 in a mutual fund in 2015. The investment will be worth Rs.35000 in 2020. Using the formula, the CAGR of this mutual fund investment will be-

CAGR= (35000/ 20000) ^ (1/5) – 1 = 11.84%

Here, the results mean the mutual fund investment gave you an average return of 11.84% per annum. You can also calculate the absolute returns on investment using the CAGR calculator. The calculation will be-

Absolute returns= (FV- PV) / PV * 100 = (35000-20000)/ 20000 * 100 = 75%

This means your mutual fund investment gave you an absolute return of 75% over its tenure.

How to calculate CAGR

Benefits Of CAGR Calculator Online

It enables investors to assess the returns in a variety of scenarios. You can use several test cases to evaluate returns in various scenarios. 

It is straightforward to use. You only need to enter the initial value, the final deal, and desired investment period, and the online CAGR calculator will take care of the rest. 

Assume that you purchased some units of an equity fund earlier and that their value has since increased. You can calculate the gains on your investment using the CAGR online calculator.

It gives you a comprehensive idea of your return on investment. 

You can also use the compound annual growth rate calculator to compare stock performance to that of peers or the industry as a whole. 

Impact of Risk Weights raised by RBI on Bank's and NBFCs

 RBI Risk Weights decision: How Will It Impact Banks, NBFCs

17th Nov, 2023

The Reserve Bank of India (RBI) on November 16 increased the risk weights on consumer credit exposure of commercial banks and non-banking finance companies (NBFCs) by 25 per cent.

Consumer credit of commercial banks and NBFCs attracts a risk weight of 100 per cent, which now has been raised to 125 per cent.

According to the RBI circular, the increase in risk weights of consumer credit exposure of commercial banks (outstanding as well as new) includes personal loans, but excludes housing loans, education loans, vehicle loans and loans secured by gold and gold jewellery.

For the NBFCs, the increase in risk weights extended to retail loans, excluding housing loans, educational loans, vehicle loans, loans against gold jewellery and microfinance/SHG loans.

The RBI also raised the risk weight credit card receivables of scheduled commercial banks and NBFCs by 25 per cent.

After this revision, credit card loans by banks will now attract a risk weight of 150 per cent, as compared with 125 per cent earlier, while those by NBFCs will attract a risk weight of 125 per cent, up from the previous 100 per cent.  

On Friday, top banking and NBFC stocks like HDFC Bank, ICICI Bank, Bajaj Finance and SBI Cards fell up to 6 per cent

Potential Impact On The Banks

According to Dr VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services, “the immediate impact of the RBI action is that this will increase the capital requirements of the banks, which, in turn, will increase their cost of capital. Since the credit demand in segments like unsecured retail loans is robust banks can easily pass on the increased cost to borrowers. So, there will be a marginal increase in the cost of credit for borrowers. However, the impact on banks’ profitability will be negligible.”

From the perspective of macro financial stability this is a welcome decision, Vijayakumar added.

The RBI move is targeted to curb incipient risks building in these segments and to reduce reliance of NBFCs on bank lending. According to analysts, the higher unsecured credit risk would negatively impact capital adequacy ratio (CARs) of banks. Capital adequacy ratio gives a quick picture to whether a bank has enough funds to cover losses and remain solvent under difficult financial circumstances.

Unsecured retails loans have been surging by 20-60 per cent year-on-year across major lenders and have been a cause of concern as highlighted by the regulator in last few months.

According to Motilal Oswal Financial Services, after the revision in risk weight, lenders could increase interest rates on these products to offset the impact on profitability. The cost of borrowings for NBFCs will also go up as banks look to increase lending rates while higher risk weight leads to higher capital consumption. There have been concerns about higher delinquencies in low-ticket personal loans, but clearly the RBI has not made any such distinction and has taken measures to curb the growth across retail segments.

The financial services firm added that the RBI action is likely to have a 30-85 basis points impact on capital ratios (excluding SBI Cards). RBL Bank, HDFC Bank, and ICICI Bank are expected to have the maximum impact, while SBI Cards remains most vulnerable with a 416 basis points impact, according to estimates.

Earning Per Share (EPS)1@

 EPS tells about the earning per equity share.

EPS= Net Profit after tax and Pref dividend / Number of equity shares 

40000/10000= Rs 4 per share 

Net Profit before tax Rs 100000

Tax 50%

10% Preference dividend on Rs 100000

Equity Share Capital (of Rs 10 each) Rs 100000 

Importance of Ratio- 

1.The earning per share helps in determining the market price of the equity share of the company.

2. It helps in estimating the company's capacity to pay dividend to its equity shareholders.

3. It is basic requirement for calculating P/E ratio.

ROCE

'Stock Investment made Easy'

Fundamental Analysis of a Company

ROCE 

Return on Capital Employed

ROCE is a profitability ratio it is also known as 'Return on Investment' ratio it indicates the percentage of Return on the total capital employed in the business

ROCE= EBIT/Capital Employed×100

The term capital employed = share capital+reserve and surplus+long term loans- ( non business assets + ficticious assets)

EBIT = Earning before Interest and tax.

Eg. EBIT= 40000

Capital Employed= 500000

ROCE= 40000/500000×100

= 8%

(Capital Employed= share capital +Reserve+long-term loan - non trading assets )

= 500000

Significance of ROCE 

1. The business can survive only when the return on capital employed is more than the cost of capital in the business.

Suppose once have been borrowed at 9% and ROC is 8% it shows that the form had not been employing the funds efficiently.

2. ROCE measures the overall efficiency of the firm. we can easily compare one form to another firm by using ROCE.

3. we can compare ROCE to Cost of capital to find out feasibility of borrowing funds from outside.

 

Debtors Turnover Ratio

 Liquidity Ratios

1.Debtors Turnover Ratio

Debtors constitute an important constituent of current asset and therefore, the quality of debtors to a great extent determines a firm's liquidity.

The Debtors Turnover Ratio=

Credit Sales/Avarage Accounts Receivable

The Account Receivable includes Trade debtors and Bills Receivable

Suppose,credit sales = 80000

Avarage Account Receivable= 22500

=80000/22500

Debtors Turnover Ratio= 3.56

Avarage Accounts Receivable= op bal+cl bal/2

Importance of Ratio= 

1. The higher ratio indicate that debts are being collected more promptly.

2. for measuring the efficiency, it is necessary to set up a standard ratio and then a ratio lower than the standard will indicate inefficiency.

3. The ratio helps in Cash Budgeting since the flow of cash from customers can be worked out on the basis of sales.

2. Debts Collection Period Ratio

 The ratio indicates the extent to which the debts have been collected in time. It gives the average debts collection period. The ratio is very helpful to the lenders because it explains to them whether their borrowers are collecting money within a reasonable time and increase in the period will result in greater blockage of funds in debtors

Eg.

Credit sales - 12000

Debtors - 1000

Bills Receivable- 1000

Debtors Turnover Ratio= credit Sales/ Accounts Receivable

12000/2000= 6 times 

Debt Collection Period= Months in a Year/ Debtors Turnover

12/6= 2 months

Importance of Ratio

1. Debtors collection period measures  the quality of debtors.

2. A shorter collection period implies prompt payment by debtors.It reduces the chances of bad debts.

3. A longer collection period implies too liberal and inefficient credit collection performance.

4. Debt collection period should be neither too liberal nor too restrictive.

It is difficult to provide a standard collection period of debtors. It depends upon the nature of industry, seasonal character of business and credit policies of the firm. In general, the amount of receivables should not exceed 3-4 months credit sales.

P/B Ratio

What is Price to Book Ratio?

The Price to Book (P/B Ratio) measures the market capitalization of a company relative to its book value of equity.

 Widely used among the value investing crowd, the P/B ratio can be used to identify undervalued stocks in the market.

Price to Book (P/B Ratio)

How to Calculate Price to Book Ratio (P/B)?

The price to book ratio, often abbreviated as the “P/B ratio”, compares the current market capitalization (i.e. equity value) to its accounting book value.

Market Capitalization → The market capitalization is calculated as the current share price multiplied by the total number of diluted shares outstanding. 

Book Value (BV) → The book value (BV) on the other hand, is the net difference between the carrying asset value on the balance sheet less the company’s total liabilities. 

The book value reflects the value of the assets that a company’s shareholders would receive if the company was hypothetically liquidated (and the book value of equity is an accounting metric, rather than based on the market value.

For the most part, any financially sound company should expect its market value to be greater than its book value, since equities are priced in the open market based on the forward-looking anticipated growth of the company.

If the market valuation of a company is less than its book value of equity, that means the market does not believe the company is worth the value on its accounting books. Yet in reality, a company’s book value of equity is seldom lower than its market value of equity, barring unusual circumstances.

Price to Book Value Ratio

Price to Book Value (P/B) Ratio

Price to Book Ratio Formula (P/B)

The price to book ratio (P/B) is calculated by dividing a company’s market capitalization by its book value of equity as of the latest reporting period.

Price to Book Ratio (P/B) = Market Capitalization ÷ Book Value of Equity (BVE)

Or, alternatively, the P/B ratio can also be calculated by dividing the latest closing share price of the company by its most recent book value per share.

Price to Book Ratio (P/B) = Market Share Price ÷ Book Value of Equity Per Share

What is a Good Price to Book Ratio?

The norm for the P/B varies by industry, but a P/B ratio under 1.0x tends to be viewed favorably and as a potential indication that the company’s shares are currently undervalued.

While P/B ratios on the lower end can generally suggest a company is undervalued and P/B ratios on the higher end can mean the company is overvalued — a closer examination is still required before any investment decision can be made. From a different perspective, underperformance can lead to lower P/B ratios, as the market value (i.e. the numerator) should rightfully decrease.

P/B Ratio < 1.0x → A sub-1.0x P/B ratio should NOT be immediately interpreted as a sign that the company is undervalued (and is an opportunistic investment). In fact, a low P/B ratio can indicate problems with the company that could lead to value deterioration in the coming years (i.e. a “red flag”).

P/B Ratio > 1.0x → Companies with P/B ratios far exceeding 1.0x could be a function of recent positive performance and a more optimistic outlook on the company’s future outlook by investors.

The price to book ratio is more appropriate for mature companies, like the P/E ratio, and is especially accurate for those that are asset-heavy (e.g. manufacturing, industrials).

The P/B ratio is also typically avoided for companies composed mostly of intangible assets (e.g. software companies) since most of their value is tied to its intangible assets, which are not recorded on a company’s books until the occurrence of an event such as an acquisition